Captives and Life Insurance

At first view, the two insurance entities may seem completely unrelated, but
upon closer study, there are at least two main areas in which they
intersect.

Life Insurance as an Investment

The first is as an investment for the captive. One reason for establishing a
captive, or at the least a side benefit of establishing a captive, is the
ability to select investments that may produce a higher return and that may not
be available in the traditional market. One such investment is ownership of a
life policy insuring the life of another person, so-called stranger-owned life
insurance or company-owned life insurance.

These policies work to provide death benefits to the owner of the policy,
the captive, upon the passing of the insured, who may have little or no
relationship to the captive owner. The public or some regulators often view
these policies unfavorably as being essentially speculative in nature. They
evolved from purchasing coverage on key personnel whose passing could
financially impact a company. Thus, a death benefit could financially assuage a
loss through hiring a replacement or otherwise covering costs that didn't
exist without the death.

Today, the captive can decide that owning a life policy on a third party can
potentially provide a greater return than other investments in some situations.
As with any investment by the captive, the regulator must approve it in advance
and since, as mentioned, some regulators don't like this investment, it may
not be approved. However, some regulators will approve such an investment, and
the return may or may not be better than other investments. I don't address
those issues in this article. As always, consult your investment professional
if you are considering such a course.

Trust-Owned Life Insurance

The other primary use of a captive with life insurance is when a life policy
owns the captive. This is seen primarily in estate planning and wealth
management scenarios. In this practice, a life policy is purchased by an
entity, usually an irrevocable life insurance trust, which in turn purchases a
life policy. This policy is often issued by a non-U.S., or offshore, life
insurance company established for this purpose. The principal reason for a
non-U.S. situs is to avoid U.S.-based life insurance investment restrictions.
In most states, there is no law against an insurance company choosing a life
policy as an investment, but traditional life insurers shy away because of the
many accounting and regulatory reporting issues.

Following specific Internal Revenue Service guidelines, the investment
portion of the policy (as the policy usually takes the form of a universal
whole life policy with investable assets) can be the shares of a captive. Thus,
any profits generated by the captive become assets of the life policy, payable
to its beneficiaries. There are many nuances on this structure, which can be
easily tailored to the specifics of an estate planning exercise.

In the estate planning field, the above described structure is known as
trust owned life insurance (TOLI). In TOLI, as in all other whole life
structures, the life policy itself is a very complex legal document, which is
rarely understood by people outside of the life insurance industry. While many
of you will be repelled, I cannot stress enough the importance of building
these structures with the input of a qualified life insurance specialist.

Many whole life policies sold in the 1980s and 1990s used current
illustrations of ultimate payouts based on then best available investment
return data. As with the recent housing/mortgage crisis, the investment
assumptions have been proven to be overly generous. So? So, the value of these
whole life, universal TOLI policies is usually in immediate danger of being out
of money. You should note that life illustrations given at the time of purchase
of the policy are not guarantees of ultimate payout.

Life premiums that have not been adjusted since purchase may now be so low
that the insurer has paid itself the necessary premium increases and accounted
for the payment as a loan taken out by the policy owner. With everything else
that you must keep up with, checking the up-to-date value of a life policy
purchased 20 years or more ago is probably way down the list. It should not be
so. As with so much else in insurance, it is vital to be dealing with
experienced professionals who will give you objective advice.

Captives and life insurance can be successfully paired, but the success is
built into the details at the very beginning.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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